I analyze macroeconomic issues from a fundamental perspective, and I analyze market behavior from a technical perspective. Original macroeconomic analysis can be found here and both macro analysis and commentary can be found on my Caps blog. If you like or appreciate my analysis, please add yourself to my Following List

Saturday, July 30, 2011

Here is an update on my long term Gold chart. Again, simply look at a monthly chart and tune out all of the noise. Gold is volatile and the daily ups and downs are going to get worse from here on out. My advice: ignore them.

If you are a short term trader in Gold then I think you are the worst type of masochist. Why would anybody want to sit through the chop, violent ranges and reversals that would accompany Gold on a short term timeframe? There are so many easier ways to make a buck. If you are a Gold 'trader', then don't read my stuff (you probably haven't been anyways).

My fundamental stance on Gold is quite different that most Gold investors (I am sure there are similarities, but there are also more than a few differences). This has been my stance for some time:

"Is Gold a hedge against inflation or deflation?". The problem is in the way the question is phrased, as if it is only a hedge against one or the other. Many people assume that either inflation or deflation affects precious metals, and that's not it at all. The answer when I think about it is: neither.

Consider in the 1980s, we had massive inflation. But Gold had already begun a major decline. Why? Because Volcker's policies had brought stability to the markets. Monetary policy was in a bad place, but he was starting to get things under control again (at least in comparison to the previous 10 years). Gold can fall in inflationary environments. It can also rise in inflationary environments. It can both rise and fall in deflationary environments as well.

I have rejected the 'Gold is an inflation hedge' argument for some time and that is reflected in my writings.

The reason why Gold will continue to do well is because of uncertainty. We see states calling for austerity because they are insolvent, we see Congress calling for austerity under the (incorrect) assumption that the Federal Government is 'insolvent', we see policy makers in Washington clueless with how to deal with the situation, we see that when Washington does take action it is usually to affect Wall Streets best interests (repeal of Glass-Steagall in 1999 being one of the worst offenses), etc.

I have demonstrated that QE is not inflationary. There are many things that people call inflationary that aren't. And many people are also discounting the deflationary tendencies of consumers being in a balance sheet recession. There are a lot of deflationary headwinds. But, QE and other monetary polices of that nature causes instability. Not through 'money expansion', but by changing asset compositions (which creates a psychological backstop based on a misunderstanding of the mechanics): 'the Bernanke Put'. This is causing much more risk taking (look at the re-explosion of margin debt over the last year). This is highly unstable.

And so if Gold is a hedge against anything, it is against instability and against government decisions that are not in the interest of a smoothly functioning marketplace (policies that promote instability), regardless if the overall effect is inflationary or deflationary.

Gold has been monetary asset for thousands of years. This is why if anything is to behave as an anchor against instability, it is Gold. I am unconvinced that things have 'returned to normal', in any sense of the term. So I tend to think Gold will be in a bull market for some time. This doesn't mean the stock market will or has to crash either. I have shown through my long term Gold / SPX correlation charts that although Gold and Equities are mostly negatively correlated, there are significant periods of positive correlation. This is also why looking at Gold ratio charts is so informative.

Friday, July 29, 2011

I have put the W wave at the gap down from this morning. We have divergence there on the 15 minute chart. However, on my 60 minute cycle chart, I do not have a bottom signal with the low today. There was no divergence confirmation today. Which means that we should expect lower lows before this wave is done. I think we have the continuation of a relief rally on Monday (likely to test the 50 day MA from the underside) and then more selling either Monday afternoon or Tuesday. More on that the closer we get.

Wednesday, July 27, 2011

Confirmation day. Very strong down day with both volume and breadth. Two important observations:

1) The 50 day-MA was broken on today's wave down. I don't think this wave will stop there. After some consolidation (likely) tomorrow I think the 200 day-MA will be tested in the next couple of days. That is where things will get interesting.

2) For those of you who care, the Russell has already broken its July 18th low. I think this is portending a real move down and not just a reaction from the last couple weeks of volatility.

Thursday, July 21, 2011

Current thoughts. I have no real confidence in the count for the last week. This afternoon could be a triangle which means we might have another up day tomorrow. At any rate, the trend is still up so take this count with a grain of salt:

Now keep in mind this is a ratio chart. If the trend projection plays out, it does not necessarily mean that Gold will go up in price. Nor does it mean that the SPX will go down in price. It just means that Gold will do better than the SPX on a relative basis. This could mean: 1. Gold rises faster than the SPX, 2. Gold goes up while the SPX goes down, 3. Gold goes down but less rapidly than the SPX. All three are viable scenarios if the Gold/SPX ratio is in a rising trend.

Wednesday, July 20, 2011

Tuesday, July 19, 2011

Again, apologies ahead of time for titling the post so stridently, but I wanted it to capture people's attention, in the same way as I wrote Why Arithmetic Stock Charts Are Worthless. And you will see in this post the exact same reasons exist for this argument as does the logarithmic vs. arithmetic price scale argument.

First, you have to read this post for all of the necessary background (Why Arithmetic Stock Charts Are Worthless). If you don't read that post then don't bother reading this post. I will do a quick summary as to why this difference is important, but I will not rehash everything.

I fully admit that I have been guilty of the sin of using the MACD for long term trend analysis. But I want to show you why I have abandoned it (and replaced it with a more appropriate indicator) for long term analysis.

First consider what the Moving Average Convergence-Divergence (MACD) is and how it is calculated (from Stockcharts)

Standard MACD is the 12-day Exponential Moving Average (EMA) less the 26-day EMA. Closing prices are used for these moving averages. A 9-day EMA of MACD is plotted with the indicator to act as a signal line and identify turns. The MACD-Histogram represents the difference between MACD and its 9-day EMA, the signal line. The histogram is positive when MACD is above its 9-day EMA and negative when MACD is below its 9-day EMA.

As such, the output from the MACD Indicator (both the MACD and the Histogram) is in terms of points.

Consider the following statement:

"The Dow moved 14 points!"

Is that a useful statement? No, it has absolutely no meaning because it has no context.

If the 14 point move happened when the Dow was at 100 (in 1928), then it was a 14% move (pretty significant). If the 14 point move happened when the Dow as at 14000 (in 2007), then it was a 0.1% move (pretty insignificant).

The absolute magnitude of moves (point moves) in the stock market are meaningless values. They are only meaningful when they are related to some reference value (converted into percentage moves).

Which as I said before: ALL GAINS AND LOSSES IN THE STOCK MARKET ARE EXPONENTIAL!! NOT ARITHMETIC!!.

So does that mean we should scrap the MACD altogether?

NO!

The MACD is an extremely useful trend following and momentum indicator, and is very useful in finding momentum divergences for short term moves (where the difference in price over the range of comparison is small).

The problem happens is when one uses the MACD to find divergences in moves where the difference in price over the range of comparison is LARGE. Then the same exponential issue shows up. Fortunately there is another indicator that serves the exact same function as the MACD, can still find momentum and divergences, has the same EMA input, but is instead expressed in percentage terms.

While MACD measures the absolute difference between two moving averages, PPO makes this a relative value by dividing difference by the slower moving average (26-day EMA). PPO is simply the MACD value divided by the longer moving average. The result is multiplied by 100 to move the decimal place two spots.

To illustrate why this is a big deal, and why using the MACD instead of the PPO to find divergence in long term trends (where there is a large price change between the two comparison periods) is incorrect, see this example chart:

All moves in the stock market are exponential/logarithmic, not arithmetic. Which means that not only do we need to look at price scales in logarithmic terms (so that we can do percentage comparisons not point comparisons), but also make sure our indicators also reflect moves expressed in percentage terms. This is not as critical when the difference in price between the two comparison points is small, but is absolutely critical when the difference in price between the two comparison points is large.

Monday, July 18, 2011

I put together another quick poll and was interested in what the community thought on this issue. Also feel free to comment below with any additional thoughts, especially if you selected 'None of the Above'.

The poll items are getting cut off on the poll screen for the second poll, here is the full text below.

This statement describes my view on the US Federal Government Deficit:

-- Deficit Hawk: The deficit is an immediate major issue. It is out of control, and it's size is the cause of current and impending economic problems (crowding out private investment, forcing an impending funding crisis as foreigners refuse to fund the US government, is a threat to national security as we won't be able to afford military spending, etc.). It is a failure of government to get Federal spending under control, as the current size of the spending is completely unsupported by taxes (far outpaces tax revenues).

-- Deficit Dove: The deficit is a long term problem that won't have to be dealt with until the intermediate term. Currently we have a balance sheet recession and high unemployment. We need aggregate spending now since deflationary / depressionary forces are the most imminent economic problems. The intertemporal Government Budget Constraint is not critical at this point and we have some time before we need to run balanced budgets / surpluses in the future.

-- Deficits Don't Matter: The US National Debt is nothing more than the accumulated net financial assets (in terms of the US Dollar) of the private domestic sector and the foreign sector. The US Deficit is governed by the following identity: Net Government Spending (Spending - Taxation) = Net Private Sector Savings (Savings - Investment) - Net Foreign Sector Balance (Net Exports - Net Imports). That is, Federal Government Spending is not discretionary and is dependent on the private sector's net savings desires and the current government trade policy (as supported by the private sector). The US Federal Government can never face a 'solvency' issue as it is sovereign issuer of the US Dollar, and is the source of all Dollars in existence. A large deficit has no more 'solvency' or 'security' risk than a small deficit or a surplus, it simply reflects the accumulated net savings desires of the non-government sectors. If the private sector desires to net save while we have a current account deficit, it is the Federal Government's responsibility to ensure enough net Government spending exists to satisfy that demand.

Thursday, July 14, 2011

I put together a quick poll and was interested in what the community thought on this issue. Also feel free to comment below with any additional thoughts, especially if you selected 'None of the Above'.

This is not embedding right in blogger. Click on this link and it will take you to the poll: Deficit Poll

Therefore any sharp move down has to be an impulse right? And is a >50% chance that it is the start of P3, right?

Things are not hunky-dory with the US economy, far from it. I still think we are in a (very complicated) secular bear market.

But there is a lot of rhetoric going around right now and a lot of macro-'analysis' that has no basis in reality. It is a lot of convertible currency economic analysis, conflated with a lot of pseudo/useless analysis, and combined with a lot of ideology. And if you listen to that crowd, the 'gig is up' on the US economy.

My advice is to ignore the noise. We are in a secular bear market. Stop looking for impulses (either up or down). Assume that a wave is corrective first and foremost. Make the market prove to you that it is an impulse (after a few months of progress). Until it does so, we are in a corrective cyclical bull market. And being impatient about the count won't change the fact that it will be messy, confusing, and with lots of false starts down.

Friday, July 8, 2011

So we got our reversal. In fact it was an island reversal much like the one on May 31. However right now the pullback is at support. We need to see some follow through down early next week. However we have a large reversal candle sitting here on the weekly chart.

But I thought in this post I would highlight the point in the form of a question, so that the answer can be immediately ascertained.

First thing to point out is that the issuance of US Federal Government bonds is a Congressional constraint, it is not an operational one. There is a history associated with this, which I delve into detail here and here. I will keep this post concise and leave the statement as a given. If you are unfamiliar with the history surrounding this, read the linked posts.

US Government Bond issuance does not 'fund' US Government spending.

US Government Tax collection does not 'fund' US Government spending.

When the US Government wishes to spend (on DoD projects, Social Security payments, Government payroll, etc.) it simply spends. Specifically the US Treasury credits private sector bank accounts that exist at the Federal Reserve. It marks up numbers in a spreadsheet. The essence of what occurs is no more complicated than that. For a more detailed description, refer here (Read the whole thing, but especially the section 'Mechanics of Federal Spending')

Currently there is a Congressional constraint that all US Federal Government spending be matched by bond sales (this is a holdover from a convertible currency standard, see above links). Additionally there is a further constraint that this 'debt' (which is a huge misnomer) be capped to some value (the 'debt ceiling'). Both of these constraints have no operational bearing nor curb the ability of the US Government via the US Treasury to credit private sector bank accounts. These are self-imposed constraints, not operational ones.

Moreover, the US Federal Government is sovereign issuer of the US Dollar, and as such is monopoly supplier of the currency. It is the source of all US Dollars in existence. It must spend these Dollars into existence before the non-government sector can accumulate them (see links above for more details). It becomes self-evident that the US Federal Government can never not have US Dollars, since it is the sole issuer of the US Dollar. Equally meaningless is the notion that the US Federal government can 'save' US Dollars (that by spending less / saving today will give it the ability to spend more tomorrow). This would be true for all currency users (citizens, companies, US states, etc.), but this is absolutely false for the currency issuer. The US Federal Government is not a 'super-household' and never has to 'finance' its spending. There is no such thing as a US Federal Government Budget Constraint (GBC).

They allow the Federal Reserve to maintain its target short term rate. Deposits within the banking system create reserves. A bank manager has a few options with what to do with those reserves, after using a portion of those reserves to ensure balances are cleared and other maintenance activities, and to maintain reserve requirements (and it is worth noting that many banking systems in other countries have no reserve requirements at all). They could let it sit in the vault as cash (earning no interest). They could keep it on account at the Federal Reserve (which relatively recently now earn a mere 25 bp, they earned 0 for a very long time before that). They could lend the reserves overnight (at an interest premium) on the interbank lending network to banks that require reserves to meet requirements. Or one of the few options beyond that is the purchase of US Government bonds. Reserves are not lent out. With the purchase of the bonds the banks are able to earn more interest in a very liquid asset (the US Treasury market is by far the biggest on the planet).

This is how this manifests in the current system: The Federal Reserve has a mandate to maintain short term interest rates consistent with its policy goals. If the banking system has a system-wide deficit of reserves relative to requirements, then competition overnight on the interbank network will drive up the short term interest rate. The Fed reacts to this by buying US Treasury bonds on the open market and prints reserves (out of thin air) in exchange for those bonds. The result is a system wide increase in reserves and a system wide decrease in the amount of US Government bonds (an asset swap). This allows the Fed to put a cap on the short term interest rate relative to its policy goals. On the flip side, If the banking system has an excess amount of reserves relative to requirements, then competition overnight on the interbank network will drive down the short term interest rate. The Fed reacts to this by selling US Treasury bonds from its portfolio on the open market. The banks trade their reserves in exchange for the bonds. The result is a system wide decrease in reserves and a system wide increase in the amount of US Government bonds (again, nothing but an asset swap). Since the Fed is the entity that 'printed' those reserves to begin with, they disappear 'into the ether' when they are returned to the Fed's balance sheet.

Here are the key points:

1 ) The US Federal Government spends (via the US Treasury) by crediting private sector bank accounts at the Federal Reserve2) There is a Congressional constraint that all US Federal Government spending be matched by Government Bond sales3) There is a 'debt ceiling' associated with the size of outstanding Government bonds4) Both 2 and 3 are self-imposed constraints with historical origins and neither are an operational constraint to Federal Spending5) The US Federal Government is monopoly issuer of the US Dollar, is the source of all Dollars, and can never 'not' have Dollars6) From 5, the US Federal Government can never become 'insolvent' in terms of honoring US Dollar denominated obligations. The only way it cannot honor its Dollar denominated obligations is if it *willingly decides* not to pay them. This is another self-imposed constraint, not an operational one7) Net Federal Government spending (spending in excess of taxation) creates net deposits which creates net reserves in the banking system. An increase in reserves pushes down the overnight lending rate. The Federal Reserve maintains control of its target overnight rate by selling US government bonds from its portfolio (via OMO) to ensure demand for reserves (the overnight interest rate) matches its target policy rate.

When all these points are considered, it becomes obvious that the US Government bond market:

a) Does not *fund* anything (It did under a convertible currency standard but does not under a fiat currency floating exchange rate standard)b) Provides the non government sector with interest income which the US Government will always be able to provide since it is monopoly issuer of the US Dollarc) Has relevance in the US Monetary System to facilitate liquidity management operations.

That's it.

So what would happen if the US Government stopped issuing bonds tomorrow?

From the perspective of the US Federal Government being able to spend .... NOTHING. It would still credit private sector bank accounts at the Federal Reserve (move numbers in a spreadsheet) just like it does today. But it would stop doing the additional step of issuing bonds as it did the crediting.

This would mean that reserves would build up in the banking system and competition for reserves would become very small, pushing the overnight rate to zero (just like it is right now with the current level of excess reserves). So basically nothing would happen that isn't already happening in the banking system.

In fact, the US Government doesn't have to void all the current bonds. Just stop issuing new ones. The old ones will then expire at maturity and the whole US Government bond system will just gradually go away over the next 3 decades (however the average bond duration held by the non-government sector is something like 6 years so it would lose relevance much sooner in actuality).

At sometime in the future, if the Federal Reserve wanted a non-zero Fed Funds Rate (current rate is a 'corridor' of 0-25 bp), it could just start paying a remuneration rate on all reserves held at the Fed (Which it is doing right now, with 25 bp payment on excess reserves). That would become the new interest rate floor, and the unnecessary song and dance of OMO could be avoided altogether.

The Private sector would come up with some new benchmark (instead of the 10 year and 30 year US Treasury bonds) to price longer term loans (corporate loans, mortgages, etc.).

When you follow this logic all the way through, you come to this very simple and inescapable conclusion:

The US Federal Government does not need the US Federal Government Bond Market (Primary Dealers, Secondary Dealers, PIMCO, etc.) to provide it with funds, IT IS THE OTHER WAY AROUND!!

All of these political stunts about not raising the debt ceiling are a literal waste of time. All of this analysis about US going the way of Greece (which is a currency *user* of the Euro, not a currency *issuer*) is a waste of time.

We have real problems to talk about and to deal with (unemployment, competitiveness, education, etc.), and we are wasting a great amount of time and energy talking about a non-issue (the debt ceiling, possible US Government 'insolvency', US Bonds rates 'skyrocketing', etc.). I suggest we stop.

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The binve standard disclaimer:This in no way constitutes investing advice. All of these opinions are my own and I am simply sharing them. I am not trying to convince anybody to do anything with their money. I am simply offering up ideas for the sake of discussion. As always, everybody is expected to do their own due diligence and to ultimately be comfortable with their own investing decisions. Any actions taken based on the views expressed in this blog are solely the responsibility of the user. In no event will MTaA or its owner be liable for any decision made or action taken by you based upon the information and/or opinion provided in this blog or in any associated RSS or Twitter Feeds.